Selling A Covered Call
A covered call is a popular options strategy. Investors use a covered call to generate income in the form of options premiums. To execute a covered call, the investor owns shares of a company, like AMD, and then writes (sells) a call option on that same stock. This tactic is often employed by an investor “who intends to hold the underlying stock for a long time but does not expect an appreciable price increase in the near term.” (Investopedia)
Most of my investments are purposefully purchased with the intention to keep them and receive dividends on a regular basis as income. Therefore, I own shares of MSFT to collect the dividend and perhaps even to sell at some point at a nice profit. I don’t want to sell the MSFT shares. However, sometimes I buy an investment that doesn’t pay a dividend because I think it will appreciate in value in a short timeframe of less than a year. Sometimes these investments don’t pay dividends. If the stock does go up in value, I have several choices I can make.
Here is a position I own: AMD. I bought the shares March 3, 2020 and they are currently worth $750 more than what I paid for them.
- I can continue to hold the shares and hope they continue to go up in price. But with AMD I won’t be paid as I wait, because AMD doesn’t pay a dividend.
- I can sell them at the current market price and book my profit and look for another opportunity.
- I can write a covered call option and sell that to another investor at a price I set for a known duration and for a price/share that I am willing to sell my shares. This blog post will illustrate a covered call for 100 shares of AMD I completed on April 16, 2020.
The beauty of this approach is that I get some immediate income if someone buys my covered call, less the commission Fidelity Investments charges. If the price of the AMD shares never reaches my set price of $59 in this example, I get to keep the money I received for the sale of my covered call and I get to keep the shares. It is almost like creating my own “dividend on-the-fly.” However, if the price per share reaches $59, and the buyer of my contract wants the shares, I am required to sell. The good news is that I also get my profit from the sale of the shares, and that profit will be more than the profit of $750 I could have gotten if I sold the shares outright today.
Of course, the downside is that the AMD shares could go to $70 per share and the person who bought my shares at $59/share will be very pleased as well. Let’s just say we will both be happy. I will have cash for another transaction, and he or she will have my shares that they can sell for a profit as well.
Because I use Fidelity Active Trader Pro (ATP) the screens in this post are from ATP. The concepts, nevertheless, are the same whatever platform you are using. You can do options trades on Fidelity’s web site as well. I just find it easier to do them using ATP.
Here is the first screen. This shows I am getting ready to enter an options trade. The trade is for a covered call because I own the shares. By selling “1” I am committing 100 shares in this transaction, which is the minimum number of shares. If I entered “2” I would be selling 200 shares. The “59” is $59. In other words, I am willing to sell my shares for $59. (I could enter a sell limit order for $59, but then I can’t be guaranteed that the order will ever trigger.) On this screen you can see that there are five Fridays. I could have selected any of them, but chose May 8, as you will see in the next images.
The next screen auto-populated with the price of $2.84 per share, because that was the price someone was offering to pay in the “BID” for this covered call. Note that the “SCO” has appeared on the price graph as well to show the price I am willing to accept for my shares.
As you can see, I changed my price to $2.95, because I want to earn more for this trade than $2.84. I was reasonably certain someone might buy at this price. I could have entered any price I wanted. So, for example, I could have entered $3.05 or $3.25. I don’t want to assume someone will pay that much, but they might. Notice that I also changed the Time In Force (TIF) to GTC, which means “Good Till Cancelled.” Perhaps the order might not trigger today and might execute on Friday or next week. I can then preview my order.
The preview screen looks like this. Note that the information I entered in the previous screen is now displayed. The symbol is not AMD, because I am not selling AMD. Rather, the symbol indicates the details of the covered call I am selling so that a computer can manage the sale.
Within a second of clicking “Place” the order was snapped up by someone at my asking price. You can see the “C” that shows where my covered call falls in the current price range. If the price rises to $59 and the shares are sold, I will make a profit of more than $1,000 plus the profit from the covered call sale.
When I look at my order register, I can see the following trade.
If I position my cursor on the “C” I can see the covered call details. I made a profit of $294.30 with about ten minutes of work. Fidelity charges a commission on options sales, so they took 70 cents.
This is the email I received from Fidelity confirming the covered call sale.
Don’t use this strategy if you don’t want to sell your shares. Once you have sold a covered call, you must be satisfied with the dollars you received from the covered call and the profit (or loss) you might otherwise receive. If AMD shares fall to $45, I cannot sell them before May 8th because I promised them to a buyer. I think there is more likelihood that the share price will reach $59 and I will get even more cash in my IRA account for a different trade.